What are we looking for?
U.S.-listed dividend paying stocks that are growing at a reasonable price
The screen
As the hunt for income continues, this week I turn my attention to U.S. markets to find dividend-paying companies that are also growing at a reasonable price, otherwise known as GARP. Experienced investors likely recognize the term GARP from investing legend Peter Lynch, who popularized it in the 1980s. Today’s strategy heralds from his use of the PEG ratio (price-to-earnings per unit of growth), among other factors. To create this strategy, I used Morningstar CPMS to rank the 2,009 companies in our U.S. database on the following factors:
* PEG ratio using expected growth rate of earnings: Here we divided the forward price-to-earnings (P/E) ratio by the expected growth rate of earnings as implied by consensus Street estimates. (Lower PEG ratios are preferred.)
* PEG ratio using reinvestment rate: This is an alternative calculation of PEG, which we determined by dividing the forward P/E by the estimated earnings per share, or EPS, less the expected dividends per share to be paid in the next 12 months as a percentage of the company’s adjusted book value per share. (Lower figures preferred.)
* Five-year deviation of return on equity: A calculation of how consistent the profitability of the company is. (Lower figures preferred.)
To qualify, stocks must pay a dividend greater than 3.2 per cent, a figure meant to exclude the bottom two-thirds of companies. Additionally, to ensure the dividends paid are reasonably sustainable, only companies with a ratio of dividend payments against earnings of less than 80 per cent were included. Finally, only stocks with a market cap of greater than US$1.6-billion were considered, which excludes the bottom one-third of stocks in the database by size.
What we found
I used Morningstar CPMS to back-test the strategy from December, 1998, to March, 2022, assuming an equally weighted 15-stock portfolio with no more than four stocks per economic sector. Once a month, stocks were sold if they fell below the top 35 per cent of the universe based on the above metrics, or if the dividend payout ratio exceeded the 80-per-cent limit. When sold, stocks were replaced with next qualifying stock not already held in the portfolio, considering the sector limits. On this basis, the strategy produced an annualized total return of 10.8 per cent, while the S&P 500 total return index produced 7.8 per cent on the same basis. Today, only 12 stocks meet the requirements to be purchased into the strategy. They are listed in the accompanying table.
This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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